When going through a divorce, selling the marital home can be a pivotal decision—not only emotionally, but also financially. A big question that often arises is how it will affect your tax liability. In his video blog, Ken Jewell covers key aspects of capital gains tax, exemptions, and strategies you can use to minimize liability during this process.
How Does Selling the Marital Home Affect Our Tax Liability?
When you sell your marital home, you might incur a tax liability, depending on the financial outcome of the sale. The tax associated with the sale of the home is known as capital gains tax. Capital gains tax applies to the profit you earn from selling an asset, in this case, your marital home. It is calculated based on the difference between what you originally paid for the house and its selling price.
Currently, capital gains tax rates range between 15% and 20%. If you make a profit on the sale of your home, this profit is subject to capital gains tax. However, exemptions may apply that can significantly reduce your tax liability.
Are We Eligible for the $500,000 Capital Gains Exemption?
Both spouses, when selling the marital home, are generally eligible for a capital gains tax exemption totaling $500,000. This exemption is $250,000 per spouse and can only be applied if you meet specific eligibility requirements. For instance, each spouse must have lived in the marital home for at least two of the last five years before the sale.
This exemption is renewable every two years. If you exhaust the $250,000 exemption this year, you could claim a new exemption again in as soon as two years. To ensure you’re maximizing this benefit properly, consulting with a tax professional is highly recommended.
How Will the Unpaid Tax Be Handled During Asset Division?
If there’s a capital gain from the sale of the marital home, the associated capital gains tax needs to be paid. Remember that profits above the $500,000 exemption trigger the tax liability, typically between 15% and 20%.
To simplify the process, the tax is often paid directly from the gross sales proceeds of the home. This ensures the tax obligation is covered before the net amount is divided between the two parties.
However, if paying the capital gains tax upfront isn’t feasible, there are options. For example, you can apply to the taxing authority for a payment plan to gradually pay off the tax. Keep in mind this option will come with late fees and interest charges on the outstanding amount.
Are There Strategies We Can Use To Minimize Capital Gains When Selling Jointly Owned Property?
Yes, there are strategies you can employ to reduce or defer capital gains tax when selling a jointly owned property. One effective approach is a 1031 exchange. With a 1031 exchange, instead of immediately paying the capital gains tax, you can defer it by reinvesting the proceeds from the sale into a similar type of property.
A 1031 exchange has specific rules:
- Within 60 days of selling the marital home, you must enter into a purchase agreement for another real estate property.
- You must close on the new property within six months of the sale.
This strategy can be particularly useful for individuals who want to transition into a new investment property while delaying their tax burden.
If We Decide Not to Sell the Marital Home Immediately, How Will That Impact Future Taxes for My Ex-Spouse and Me?
If you choose not to sell the marital home immediately, the timing of the sale will affect the tax implications for both you and your ex-spouse. For instance, if the home continues to be rented out or lived in for a certain period before being sold, the capital gains tax structure you encounter will depend on the tax laws in effect at the time of the sale.
Currently, capital gains tax rates sit between 15% and 20%, but these rates may change based on future tax laws. Additionally, any future appreciation of the home’s value could increase the taxable gain. It’s essential to be aware that tax exemptions, like the $500,000 capital gains exclusion, may not be available if the house ceases to qualify as your primary residence.
When deciding whether to defer the sale, it’s wise to consider both current tax implications and how future tax policies might impact your financial situation.
If you are navigating the sale of your marital home during or after a divorce, contact us to see how we can assist you.